The International Monetary Fund, other economic institutions, politicians, experts, and a good number of indicators predict a new economic downturn. The causes will be diverse but the significant one is that debt worldwide has grown at an exaggerated rate. According to the report of the International Finance Institute, IIF, global debt is $247-plus trillion, 318% of GDP.
In the 2000s or noughties an expansive fiscal and monetary policy with low interest rates generated significant public deficits, a strong increase in borrowing and created a stock market and real estate bubble that erupted in 2007, forcing central banks to push for a huge monetary expansion – Quantitative Easing – to get out of the crisis eventually.
With a lot of financial liquidity in the market at a cost close to zero, the economy has regained growth and, for now, inflation is under control. But the economic cycle cannot be considered closed until central banks’ debt and interest rates return to normal. Trust in the International Monetary System, and the main currencies remains, but if some day trust in one important currency is lost, the situation would be very delicate.
Now the economic recovery has been achieved, it is time to gradually restore debt and interest rates to reasonable levels (aka tapering). The US Federal Reserve (Fed) has already increased its interest rate and announced that it will continue to do so. The consequences have been immediate, with the withdrawal of investments from emerging countries, such as Argentina, Brazil, South Africa, India or Turkey, to invest in American bonds. The European Central Bank (ECB) has also announced that by the end of 2018 it will stop buying debt and that interest rates will rise as the economy improves (but not before the summer of 2019).
What will be the consequences of tapering? Will it destabilize the economy? What are the risks of entering a new recession? Will the current monetary system resist? How will the governments that are highly indebted deal with recession?
In addition to indebtedness, there are many current risk factors that can contribute to a new recession. Political instability, economic imbalances, the weaknesses of the international monetary system, the self-imposed isolation policy of the US, the increase in protectionism and populism, or the existence of serious political and economic uncertainties. It is a situation that generates confusion and mistrust and therefore calls for, among other decisions, reforming the international monetary system so as to prevent the situation getting out of control.
Greenback glory over?
For 70 years, the dollar has been, and is, the superpower of the global financial and monetary system. Despite the steep growth in the Chinese economy, and the use of the renminbi, the primacy of the dollar goes unquestioned. But a transition to a safer and more stable multipolar system must be promoted, in which currencies such as the euro, renminbi, and the IMF itself play a greater role.
The most rational proposal is that the IMF promote the emission and employment of the Special Drawing Rights, SDR, to gradually convert them into the main reserve currency. It would give stability and confidence to the system at a time when, due to globalization, geopolitical changes, digitization and the need to protect the environment, it is undergoing profound transformations.
A reform based on SDRs taking on a more central role is feasible and is probably the only alternative to the current monetary system. But this proposal generates strong resistance from the US for fear of losing the many privileges that the pre-eminence of the dollar brings as the main reserve currency. Nor does the IMF, in which the US has a dominant influence, seem interested in promoting SDRs.
What will happen if the next crisis comes? In the 2008, the main central banks poured an astronomical amount of monetary liquidity into the system. Now, the concern is that, given the high levels of debt, an operation of this magnitude cannot be repeated, if you do not want that the market lose confidence in a monetary system based on fiduciary, or a currency not backed by a physical asset.
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The risk of a new recession is affecting all countries, and therefore is a global problem that demands international coordination at the highest level. Probably the G20 would be the most appropriate forum.
The IMF should gradually convert SDRs into the basic currency of the world system, act as a bank of central banks and as a lender of the last resort. Given the extraordinary power that the IMF would have, it should be politically more representative, evaluate the social repercussions of its actions and render account.
All the most heavily indebted countries should draw up plans to reduce their debt. With regard to the eurozone, it must be recognized that it has succeeded in reducing the budget deficit, but at the cost of increasing the debt, far exceeding the target of 60% of GDP. The target or allowed percentage ratio of debt to GDP should be frozen, the authorities should initiate a gradual process of its decrease, restructure part of the debt of the most heavily indebted countries and deepen financial integration.
In summary: the international monetary system has a serious problem to solve, but there is not enough political pressure to force the main political and monetary authorities, within the framework of multinational institutions, to take the necessary decisions to avoid a new crisis causing instability and sorrow in the economy and the society. Should we really wait for the recession to begin before taking action?
Francesc Raventós is an economist, former dean of the Official Economist Association of Spain in Madrid, deputy mayor of Barcelona and co-author of Economic and Social Strategic Plan for the future of Barcelona.